The Federal Reserve's aggressive interest rate hikes have been impacting S&P 500 profits, according to a recent analysis by Goldman Sachs. The central bank's inflation-fighting efforts have raised borrowing costs, with corporate earnings feeling the pinch.
As of Monday, the index's return on equity (ROE), excluding financial firms, has seen a slump of 69 basis points this year. Goldman Sachs strategists pointed out that the ROE for the S&P 500 has been on a downward trend since its peak in the second quarter of last year, falling to 23.4% this year. Despite this decline, the current ROE still ranks at the 97th percentile for S&P 500 ex-Financials readings dating back to 1975.
Interest rates currently hover between 5.25% and 5.5%, marking their highest level since 2001. The Fed's decision to raise rates has significantly increased borrowing costs for companies listed on the S&P 500 index. These costs have seen a jump of around 40 basis points in 2023, representing the largest increase in nearly two decades.
This rise in rates has also been a major factor affecting S&P 500 profits this year. A decline of 31 basis points in ROE is entirely attributable to these higher borrowing costs, according to Goldman Sachs' research.
Strategists at Goldman Sachs noted in a recent report that "In the new 'higher for longer' rates environment, the key risk for S&P 500 ROE will be higher interest expenses and lower leverage". They also highlighted a potential departure from historical trends if interest expenses and leverage continue to weigh on ROE. Traditionally, companies have used low borrowing costs and higher leverage to boost profits. One Fed study indicated that more than 40% of company profits in the three decades leading up to 2019 can be attributed to lower interest rates and corporate taxes.
Looking ahead, Goldman Sachs predicts that the S&P 500's ROE, excluding financials, will likely stabilize next year. The bank sees a low chance of "substantial expansion" through 2024.
Other Wall Street forecasters have also warned of potential earnings trouble for firms as the Fed's tightening efforts continue to impact the economy. Morgan Stanley's chief investment officer has previously warned that falling inflation could pose another challenge to corporate profits, potentially leading to the worst earnings recession since 2008.
This article was generated with the support of AI and reviewed by an editor. For more information see our T&C.